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Russ: This is the BusinessMakers Show, heard here and online at theBusinessMakers.com. Okay. Now it's time for the Aflac BusinessMakers Flashback brought to you by Aflac. Ask about it at work. And this that part of the show where we go back and replay some of our favorites. And for this morning, we're going to revisit a very popular interview we had with Mr. Chris Colvert back in November of 2006 when Chris did just an outstanding job of explaining why startups should consider being an S corporation. I started off the discussion by asking Chris, "What is an S corporation?"
Chris: Well, Russ, it's a corporation, just like any other corporation. And what makes it special and why it's called "S," is because of its tax attributes. All corporations are taxed under the Internal Revenue code one way or the other unless they're exempt from tax. In particular, the main types of business corporations that are not exempt from tax are either known as C corporations or as S corporations. For many years, we just had one flavor, the C corporation, and it had a tax disadvantage because its profits were taxed twice, once at the corporate level and then again at the shareholder level.
Russ: So if you were a small business and you were a C corp and you had a good year and you made $100,000.00, you paid taxes on that. And if you wrote yourself a check at all, you paid income taxes on that.
Chris: That's correct, Russ. And finally, the government realized that we wanted to find a way to allow small businessmen, entrepreneurs, people willing to take the risk with their capital, to have a more tax-friendly investment, and that's when we created the S type of taxation of corporations. It's the rough equivalent of taxing the corporate earnings as though it were a partnership. Now we're gonna have some guys out there that'll play "Gotcha,' with me and say, "No, Chris. There are distinctions between taxation of partnerships and taxation of S corps." And so when we get to the trivial pursuit part of the program -
Russ: But for the general description, that's a good analogy, right?
Chris: It's a very - it's a pretty fair fit for our purposes today.
Russ: Okay. So the creation of S corporation status was something the government did that was pro-business and helped small businesses to be treated more fairly at tax time. So then I wanted to know how the mechanics of paying taxes would work if an S corporation that I was part of made a profit.
Chris: Well, you have a choice, Russ. You will not pay corporate taxes. The S corp in general is more or less a reporting entity. With certain minor exceptions, the S corporation doesn't pay taxes on its own. Instead, the S corporation files a report with the government known as a K1, and that K1 tells the shareholders and the government what each shareholder's portion is of the profits of the company. And then the shareholders pay taxes on their share of the profits based on their own tax situation.
Russ: Okay. So if I were a shareholder, I could conceivably have to pay taxes on it and not have any money income coming from it, right?
Chris: Well, that's right. The money could still be trapped inside the corporate bank account. So, Russ, if I were you, I'd make dang sure that I had some way to vote that money outta the company into my pockets, at least enough to pay your taxes with.
Russ: Okay. And so then if it comes out of the company, well, the company deducts it and it lowers the company's profit, but then the individual pays regular income tax, right?
Chris: Yes. And really what happens is when you pay that money out for whatever reason, it also lowers the taxpayer's tax cost of his stock. We call - we have a word for that. It's called "basis.' So your basis will come down when that money comes outta there.
Russ: Okay. Let's rewind back to the beginning and let's say that I'm starting a company and I've just listened to Chris Colvert here give me this advice and I know I own an S corporation as opposed to a standard C corporation. What do I have to do to make sure that my corporation is an S corporation?
Chris: Well, you've got a deadline, Russ. And so you don't want to fall asleep. Just forming company is not enough. Getting your S qualification requires some affirmative action on your part. You've got to file a form called 2553. And if you don't file that form in time, in most cases - now this sounds real taxy - the 15th day of the 3rd month after you form your company, basically, then you will lose the ability to get S treatment for that year.
Russ: Okay. So the IRS would think if you didn't do this that you're a C corp, and you're just gonna go down the path paying taxes like a C corporation.
Chris: That's right. And you wouldn't be a very happy camper about that.
Russ: Okay. And that wraps up our discussion of S corporation status with the late, great, Chris Colvert. And that wraps up the Aflac BusinessMakers Flashback brought to you by Aflac. Ask about it at work. And now it' time for another business survival tip. So let's welcome Carl Kleimann, of Odyssey OneSource.
Carl: Hello Business Owners this is Carl Kleimann with another Business Survival Tip from Odyssey One Source. According to the small business administration, small businesses accounted for more than 60 percent of U.S. job growth during the decade from 1995 to 2005. Entrepreneurial firms have proven to be extremely effective at finding new ways to do old things and are constantly creating a competitive advantage over their larger counterparts. Consider how startups like Amazon and Google forever changed the industries in which they exist.
So what did these and other memorable small business success stories have in common? They realized early on that in today's knowledge economy, they simply had to compete with their larger counterparts in areas such as attracting, developing, and retaining valuable employees and were willing to invest in Human Resource best practices that enabled them to do so. This can seem like a daunting feat for entrepreneurial firms that can't cost justify their own HR department but unlike years past, there are outsourcing options available today that allow small businesses to access the level of HR support they need, as they need it. That may begin with hiring strategies and progress to employee training and development, compensation and benefits, and dispute resolution as the business grows.
I am Carl Kleimann and this has been another Business Survival Tip from Odyssey One Source, ranked as the number one Professional Employer Organization for 3 years running by the Black Book of Outsourcing. For more information on this and other useful tips for employers, visit odysseyonesource.com.
Russ: And that wraps up this mornings Business Survival Tip. Stay tuned in this mornings featured guest segment as the BusinessMakers Overtime team of Esther Steinfeld and Katie Laird sit down and talk with Laura Capper, founder and CEO of Cap Resources, the consulting firm that helps start-ups start-up. You're listening to BusinessMakers Show heard here and online at theBusinessMakers.com.